Rate Making: Pure Premium and Loss Ratio Methods
Compare the pure premium and loss ratio ratemaking methods for actuarial pricing on Exam STAM.
Pure Premium Method
The pure premium method calculates the indicated rate directly. The indicated rate per exposure equals (projected ultimate losses + LAE) / earned exposures, plus fixed expenses per exposure, all divided by (1 minus variable expense ratio minus profit and contingency factor). This method requires reliable loss and exposure data by class but does not require current rate information. It produces an indicated rate level directly.
Loss Ratio Method
The loss ratio method calculates an indicated rate change relative to current rates. The indicated change factor equals the projected loss and LAE ratio divided by the target (permissible) loss ratio. The target loss ratio equals 1 minus the total expense ratio minus the profit provision. This method requires on-level earned premium (adjusted to current rate level) and is useful when exposure data is unreliable or unavailable. Exam STAM problems often require adjusting historical premiums to current rate levels using parallelogram or other on-leveling techniques before applying the loss ratio method.